Among the common investment strategies is using bonds in a portfolio. Bonds can be a solid addition to any investment portfolio, when used in the proper asset allocation for your goals and needs. However, it’s a good idea to understand the basics of bonds before you get started.
Unlike stocks, which represent equity or ownership in a company, bonds are more like loans. When you invest in loans, you are actually investing in debt. The organization in question issues bonds as a way to raise funds, and then pays you back.
When you invest in bonds, you receive interest payments during the period of the bond’s term, and then, when the bond matures, you receive your principal back. There are two main types of bonds that investors can choose from:
Basically, you are lending money to someone else. So you want to make sure that you are lending to an entity that is likely to repay your loan.
Many investment professionals consider bonds as relatively safe. Some even believe that there are bonds that are just as good as cash. However, like stocks, it largely depends on the organization that is issuing the bonds. While bonds are considered safe, there are still risks that come with investing in them:
You can get an idea of how “safe” a bond investment might be by paying attention to the ratings given to the debt. Corporations and governments have their credit rated. The higher a credit rating, the more likely it is that your bond will be paid in full. A government, like Greece, that is on shaky ground might end up defaulting on some of its debt. In fact, many bondholders found themselves not getting back what they put in during Greece’s “selective default.”
The reason that some investors choose riskier bonds is that there is a chance at a higher return. A company or government with a low credit rating has to offer higher interest rates in order to attract bond buyers. Spain’s interest rate has been near 6% recently because there are worries of default. Contrast that with the yield on US Treasury securities, which is hovering around the 1% mark. US bonds are considered the safest in the world, and the low yield is the price investors pay for that security.
However, even the safest bond could default. Even US Treasuries aren’t completely safe, and you need to keep that in mind as you invest in bonds.
There are many options when it comes to investing in bonds. If you want to invest in US Treasury securities, you can do so by setting up an account at TreasuryDirect.gov. You can buy bonds through a brokerage, but there is usually a premium to do that. It’s often cheaper to just get them from the source.
Other bonds can be purchased via brokerage, or directly. Another option is to invest in bond index funds, or bond ETFs. These are low cost, and you get exposure to a variety of bond investments, rather than picking them on your own.
Bonds can be useful, along with dividend stocks, in an income portfolio, or they can provide you with a little more stability in a more traditional asset allocation.
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